An Analysis of Macro-Economic Policies
Course Name: Introduction to Economics
Course Code: PCHR 1208
Submitted by:
Group B
Dept. of Peace Conflict & Human Right Studies
Submitted to:
Amina Khatun
Lecturer
Dept. of Economics
Submission Date: 10th April ,2023.
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Acknowledgement
This term paper on Macro-Economic Policies: Fiscal and Monetary Policies is the
first complete term paper, we have done in our second semester of the first year of
Bangladesh University of Professionals. First, we want to thank the Almighty Allah
for giving me the opportunity to finish this term paper properly. Then a countless
amount of gratitude to my ‘Introduction to Economics’ course teacher, Lecturer
Amina Khatun, Department of Economics, Bangladesh university of Professionals,
for her constant help, suggestions and monitoring in the class which helped a lot
during the preparation of this term paper.
Abstract
Fiscal and monetary policies are the two main macroeconomic tools that
governments and central banks use to manage their economies. Fiscal policies
involve changes in government spending, taxation, and borrowing to influence
aggregate demand, economic growth, and income distribution. Monetary policies,
on the other hand, involve changes in the money supply, interest rates, and credit
conditions to influence the cost and availability of credit, inflation, and employment.
This paper aims to provide a comprehensive overview of the definition, goals,
differences, types, tools, and examples of fiscal and monetary policies, and to
compare and contrast their effectiveness and limitations in achieving
macroeconomic stability and sustainability.
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Macro-Economic Policies:
Fiscal and Monetary Policies
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Table of Contents
I. Introduction
5
II. Fiscal Policy
A. Definition of Fiscal Policy
6
B. Goals of Fiscal Policy
7
C. Differences between Fiscal and Monetary Policies
7
D. Types of Fiscal Policy
8
E Tools Used in Fiscal Policy
9
F. Examples of Fiscal Policy
10
III. Monetary Policy
A. Definition of Monetary Policy
11
B. Goals of Monetary Policy
12
C. Differences between Monetary and Fiscal Policies
12
D. Types of Monetary Policy
13
E. Tools Used in Monetary Policy
13
F. Examples of Monetary Policy
15
IV. What does government do to comedown the economy when
A. Inflation is high.
17
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B. People’s income is very low.
17
V. Conclusion
19
VI. Reference
20
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I. Introduction
The study of the behavior of the entire economy is known as macro-economic
policies. It is focused with determining the major economic aggregates, including
the level of national output, unemployment, inflation, and balance of payments. The
study of the overall health of the economy is referred to as macroeconomics.
Macroeconomics deals with the overall aggregate impact of microeconomics while
microeconomics explores how individual people make decisions. For the
government to comprehend and foresee the long-term effects of its policies,
macroeconomics is essential.
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II. Fiscal Policy
A. Definition
Fiscal policy refers to the use of government spending, taxation, and borrowing to
influence the economy. Unlike monetary policy, which is implemented by the
central bank, fiscal policy is implemented by the government.
Governments can use fiscal policy to achieve a variety of macroeconomic goals,
such as promoting economic growth, reducing unemployment, and stabilizing the
economy. For example, during a recession, the government may increase its
spending on infrastructure projects or provide tax cuts to stimulate economic activity
and reduce unemployment. On the other hand, during a period of high inflation, the
government may increase taxes or reduce spending to reduce demand and control
inflation.
Fiscal policy can have both short-term and long-term effects on the economy. In the
short term, it can affect consumer and business spending, while in the long term, it
can affect the productivity and competitiveness of the economy. The effectiveness
of fiscal policy can depend on a variety of factors, including the size and composition
of the government’s budget, the level of public debt, and the country’s economic and
political institutions.
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B. Goals
The goals of macroeconomic policies for fiscal policies are:
1. Promoting economic growth: Fiscal policies can be used to stimulate economic
growth by increasing government spending, reducing taxes, or both.
2. Reducing unemployment: Fiscal policies can be used to reduce unemployment
by increasing government spending, which can create jobs, or by reducing taxes,
which can stimulate economic activity and create jobs.
3. Stabilizing the economy: Fiscal policies can be used to stabilize the economy
during times of economic instability, such as during a recession, by increasing
government spending or reducing taxes to stimulate demand and economic activity.
4. Promoting income equality: Governments can use fiscal policies to promote
income equality by implementing progressive tax policies and redistributing income
through social welfare programs.
5. Controlling inflation: Governments can use fiscal policies to control inflation by
reducing government spending and increasing taxes, which can reduce demand and
lower prices.
C. Differences Between Fiscal and Monetary policies
Some key differences between fiscal policy and monetary policy include:
1. Tools Used: Fiscal policy primarily uses taxation, spending, and borrowing,
while monetary policy uses interest rates, reserve requirements, and open
market operations.
2. Authority: Fiscal policy is determined by the government and legislature,
while monetary policy is set by the central bank.
3. Timeframe: Fiscal policy can take longer to implement and have a more
delayed impact on the economy, while monetary policy can be implemented
more quickly and have a more immediate effect.
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4. Targets: Fiscal policy aims to influence the overall level of economic activity
and address social and economic issues such as income inequality, while
monetary policy primarily targets inflation and financial stability.
D. Types
There are two main types of fiscal policy: expansionary and contractionary.
1. Expansionary fiscal policy:
Expansionary fiscal policy, designed to stimulate the economy, is most often
used during a recession, times of high unemployment or other low periods of
the business cycle. It entails the government spending more money, lowering
taxes or both.
The goal of expansionary fiscal policy is to put more money in the hands of
consumers so they spend more to stimulate the economy. Explained in
economic language, the goal of expansionary fiscal policy is to bolster
aggregate demand in cases when private demand has decreased.
2. Contractionary fiscal policy:
Contractionary fiscal policy is used to slow economic growth, such as when
inflation is growing too rapidly. The opposite of expansionary fiscal policy,
contractionary fiscal policy raises taxes to cut spending. As consumers pay
more taxes, they have less money to spend, and economic stimulation and
growth slow.
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Under contractionary fiscal policies, the economy usually grows by no more
than 3% per year. Above this growth rate, negative economic consequences –
such as inflation, asset bubbles, increased unemployment and even recessions
– may occur.
E. Tools
The major tools of fiscal policy (government spending and taxation) and monetary
policy (central bank control of the money supply). These tools are used to achieve
macroeconomic equilibrium.
The two major fiscal policy tools that the U.S. government uses to influence the
nation's economic activity are tax rates and government spending.
1. Governmental Outlays:
Purchases of products and services are included in government spending, such as a
fleet of brand-new cars for government workers or missiles for national defense.
Because it has the potential to increase or decrease real GDP, government
expenditure is a tool for fiscal policy. The government can affect economic
production by changing its spending.
2. Taxes:
Taxes are a tool for fiscal policy because they have an impact on the income of the
typical consumer, and changes in consumption influence real GDP. Therefore, the
government can affect economic production by changing taxes. There are several
methods to alter taxes. The first is that effective tax rates can be altered. Second,
they can be completely removed or the tax laws can be changed.
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F. Examples of Fiscal Policies:
Prominent examples of fiscal policies:
1.
2.
3.
4.
5.
6.
7.
8.
9.
To raise the level of investments
To check the fluctuations in the market
Rapid economy development
For proper allocation of the resources
To increase per capita income
Control on inflations
Price and economic stability
Increase the rate of employment opportunities
To divert capital resources from less productive to more productive
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III. Monetary policy
A. Definition
Monetary policy refers to the actions taken by a country’s central bank to manage
the money supply and achieve certain macroeconomic goals, such as controlling
inflation, stabilizing the economy, and promoting economic growth.
Central banks implement monetary policy through various tools, such as setting
interest rates, adjusting reserve requirements for banks, and buying or selling
government securities. For example, when a central bank lowers interest rates, it
makes borrowing cheaper, which can stimulate economic activity and increase
inflation. Conversely, when a central bank raises interest rates, it can slow down
economic activity and decrease inflation.
The effectiveness of monetary policy can depend on a variety of factors, including
the state of the economy, the level of inflation, and the transmission mechanisms
through which changes in monetary policy affect the broader economy.
B. Goals
1. Controlling inflation: Monetary policies can be used to control inflation by
adjusting interest rates and the money supply.
2. Promoting economic growth: Monetary policies can be used to promote
economic growth by lowering interest rates, which can stimulate borrowing and
investment.
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3. Stabilizing the economy: Monetary policies can be used to stabilize the economy
by adjusting interest rates and the money supply during times of economic
instability.
4. Maintaining financial stability: Monetary policies can be used to maintain
financial stability by regulating the banking system and ensuring the stability of the
financial markets.
C. Differences Between Fiscal and Monetary policies
Monetary policy and fiscal policy are two important tools used by governments to
influence economic activity. While both policies aim to stabilize the economy, they
differ in several ways:
1. Tools Used: Monetary policy primarily uses interest rates, reserve
requirements, and open market operations, while fiscal policy uses taxation,
government spending, and borrowing.
2. Authority: Monetary policy is set by the central bank, while fiscal policy is
determined by the government and legislature.
3. Timeframe: Monetary policy can be implemented quickly and has a more
immediate impact on the economy, while fiscal policy can take longer to
implement and has a more delayed effect.
4. Objectives: The main objective of monetary policy is to maintain price
stability, whereas the main objectives of fiscal policy are to stabilize
economic growth, address income inequality, and promote social welfare.
5. Targets: Monetary policy targets inflation and financial stability, while
fiscal policy targets the overall level of economic activity and may also
address social and economic issues.
6. Transmission mechanism: The transmission mechanism of monetary
policy is through interest rates and credit markets, while the transmission
mechanism of fiscal policy is through government spending and taxation.
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D. Types
Monetary policies are seen as either expansionary or contractionary depending on
the level of growth or stagnation within the economy.
Contractionary:
A contractionary policy increases interest rates and limits the outstanding money
supply to slow growth and decrease inflation, where the prices of goods and services
in an economy rise and reduce the purchasing power of money.
Expansionary:
During times of slowdown or a recession, an expansionary policy grows economic
activity. By lowering interest rates, saving becomes less attractive, and consumer
spending and borrowing increase.
E. Tools
1. Open Market Operations:
Open market operations refer to the Federal Reserve purchasing or selling
government bonds and other securities on the market.
It is referred to as conducting open market operations when the Federal Reserve
buys or sells bonds and other securities. The Federal Reserve instructs its bond
traders at the New York Fed to buy bonds on the country's bond markets from
the general public in order to increase the amount of money available. The money
that the Federal Reserve pays for the bonds adds to the total amount of dollars in
the economy. These additional funds are divided between bank accounts and cash
storage. The amount of money in circulation increases one to one for every
additional dollar retained as currency.
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However, a dollar invested in a bank increases the money supply by more than
one dollar because it boosts bank reserves.
2. Reserve Requirement:
But putting a dollar in a bank increases the money supply by more than a dollar
because it increases bank reserves.
Increasing the potential revenue, the deposit may bring into the banking system.
One of the tools the Fed uses to implement monetary policy is the Reserve
Requirement Ratio. The Reserve requirement ratio refers to the amount of funds
banks must keep in their deposits.
Reserve requirements have an impact on how much money the banking system
can produce with each dollar of reserves. A rise in reserve requirements implies
that banks will be required to retain more reserves and will be able to loan out
less of each dollar that is deposited. As a result, banks are unable to lend as much
money as they once could, which reduces the amount of money in the economy.
A drop-in reserve requirement, on the other hand, decreases the reserve ratio,
boosts the money multiplier, and increases the money supply. Changes in reserve
requirements are only used in exceptional circumstances by the Fed since they
disrupt the banking industry's operations. When the Federal Reserve raises
reserve requirements, certain banks may find themselves short of reserves,
despite their deposits having remained unchanged. Consequently, they must
restrain lending until they have increased their level of reserves to the new
minimum requirement.
3. Discount Rate:
The discount rate is the interest rate on loans made to banks by the Federal
Reserve.
The discount rate is another important monetary policy tool. Through the loan of
funds to banks, the Federal Reserve may also enhance the money supply in the
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economy. The interest rate on loans made to banks by the Federal Reserve is
known as the discount rate. In order to fulfill regulatory requirements, meet
depositor withdrawals, originate new loans, or for any other business purpose,
banks borrow from the Federal Reserve when they believe they do not have
enough reserves on hand to meet those requirements. There are many ways
commercial banks can borrow money from the Federal Reserve.
Banking institutions traditionally borrow money from the Federal Reserve and
pay an interest rate on their loan, which is known as the discount rate. As a result
of the Fed's loan to a bank, the banking system ends up with more reserves than
it would have otherwise, and these increased reserves enable the banking system
to produce more money.
The discount rate, which the Fed controls, is adjusted to affect the money supply.
An increase in the discount rate makes banks less likely to borrow reserves from
the Federal Reserve. As a result, a rise in the discount rate decreases the number
of reserves in the banking system, thereby reducing the amount of money
available for circulation. On the other hand, a lower discount rate encourages
banks to borrow from the Federal Reserve, thus boosting the number of reserves
and the money supply.
F. Examples of Monetary Polices:
Prominent examples of Monetary policies:
1. Full employment: Full employment has been ranked among the foremost
objectives of monetary policy. It is an important goal not only because
unemployment leads to wastage of potential output, but also because of the loss
of social standing and self-respect.
2. Price stability: One of the policy objectives of monetary policy is to stabilize
the price level. Both economics and flavor this policy because fluctuations in
price bring uncertainty and instability to the economy.
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3. Economic growth: One of the most important objectives of monetary policy
in recent years has been rapid economic growth of an economy. Economic
growth is defined as “the process whereby the real per capita income of a country
increases over a long period of time.
4. Balance of payment: Other objectives of monetary policy since the 1950s
has been to maintain equilibrium in the balance of payments.
5. Exchange rate stability: Exchange rate is the price of a home currency
expressed in terms of any foreign currency. The monetary policy aims at
maintaining the relative stability in the exchange rate.
6. Equal income distribution: Many economics used to justify the role of the
fiscal policy is maintaining economic equality. However, in recent years
economists have given the opinion that the monetary policy can help and play a
supplementary role in attaining an economic equality.
7. Neutrality of money: Economist Robertson has always considered money as
a passive factor. According to him, money should play only a role of medium of
exchange and note more than that. Therefore, the monetary policy should regulate
the supply of money.
A country's government and the country's central bank jointly decide on a plan to
control inflation. The plan adopted by the central bank is called the monetary
policy and the action taken by the government is called the fiscal policy.
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IV. Government’s role calm down Economy
When inflation is high:
When inflation is high, central banks can use monetary policy tools to try to control
it. The primary monetary policy tool used by most central banks is the adjustment of
interest rates.
The central bank can increase interest rates to decrease the amount of money in
circulation and slow down economic activity. This can reduce the demand for goods
and services, which can help to decrease inflation.
In addition to adjusting interest rates, the central bank can also use other monetary
policy tools such as open market operations, reserve requirements, and quantitative
easing to control inflation. These tools can affect the supply of money in the
economy and can be used in combination with interest rate adjustments to achieve
the central bank's inflation targets. It's worth noting that high inflation can have a
variety of causes, such as supply-side shocks, cost-push factors, or demand-pull
factors. The central bank's response to high inflation may vary depending on the
underlying cause and the central bank's objectives.
When people’s income is very low:
When people's income is very low, fiscal policy can play an important role in helping
to stimulate economic growth and improve the well-being of individuals.Fiscal
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policy refers to the use of government spending and taxation to influence the
economy.
One way that fiscal policy can be used to support low-income individuals is through
the implementation of social welfare programs. These programs provide financial
assistance to those who are struggling to make ends meet, such as unemployment
benefits, food stamps, and housing assistance. By increasing government spending
on these programs, individuals with low incomes can receive the support they need
to meet their basic needs and improve their overall economic situation.
Another way that fiscal policy can support low-income individuals is through
progressive taxation. Progressive taxation is a system in which individuals with
higher incomes pay a higher percentage of their income in taxes. The revenue
generated from these taxes can then be used to fund social welfare programs or other
initiatives that support low-income individuals.
In addition to these measures, fiscal policy can also be used to stimulate economic
growth, which can in turn benefit low-income individuals by creating job
opportunities and increasing wages. This can be accomplished through government
investment in infrastructure, education, and other areas that support economic
growth.
Overall, fiscal policy can play an important role in supporting individuals with low
incomes by providing financial assistance, implementing progressive taxation, and
stimulating economic growth.
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V. Conclusion
In conclusion, macroeconomic policies play a crucial role in shaping the overall
economic performance of a country. The government can use various tools to
influence the macroeconomic variables such as inflation, economic growth, and
employment levels.
Monetary policy, which is controlled by the central bank, focuses on managing the
money supply in the economy, primarily through interest rate adjustments. Fiscal
policy, which is controlled by the government, involves changes in taxation and
government spending.
Both monetary and fiscal policies have their strengths and weaknesses, and their
effectiveness may depend on the prevailing economic conditions. For example,
during periods of high inflation, monetary policy may be more effective in
reducing inflationary pressures. In contrast, during periods of recession, fiscal
policy may be more effective in stimulating economic growth.
A well-designed macroeconomic policy framework can help to achieve
macroeconomic stability, sustainable economic growth, and improved living
standards for citizens. However, the success of these policies depends on the
government's ability to implement them effectively and efficiently. Therefore,
policymakers must continuously monitor and evaluate the effectiveness of
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macroeconomic policies and make necessary adjustments to ensure their optimal
performance.
VI. Reference
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Submitted By
Members of Group B –
1. MYSHA TABASSUM –
2. SALMAN SARWAR –
3. RAJ SORKAR –
4. ANINDO BISWAS ANTU –
5. SABRINA IRIN BIVA–
6. MAYESHA PRIITY –
7. JARIN TASNIM LOGNO –
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